Some permanent life insurance policies offer cash value on top of a death benefit. If your policy has cash value, it's your money and you can take it out whenever you want. However, when you take money out of a life insurance policy, you might owe taxes. Whether you'll owe money depends on your total investment gains and how you cash in your policy.
Cash value is money in a life insurance that you can take out and spend while you are alive. Only permanent policies offer cash value. If you have a term policy, it doesn't have any cash value. You can cancel a term policy whenever you want, but you won't get any money back. If your permanent policy has cash value, the balance is a combination of your premium payments and investment gains. As long as you keep your policy active, the insurance company will invest and grow your money.
One way to cash in part of your insurance money is through a withdrawal. You can make a withdrawal for any amount you want from your cash value. When you take money out of your life insurance, you get your premium payments back tax-free. If you take out more than you paid into the policy, your gains are taxed as income. You can also take money out at any age. Life insurance isn't a retirement plan, and the IRS doesn't charge an extra penalty when you take money out early. All you ever owe is income tax on your gains.
You can also cash in your entire policy by cancelling it. The insurance policy will end your contract and mail you a check for your entire cash value balance. You will owe income tax on all the investment gains in your policy that year. When you cancel your policy, you will lose your insurance coverage. If you want to stay covered, some companies let you use part of your cash value to buy a smaller policy. This option lets you keep some insurance coverage while cashing out your extra money.
One other way to take money out of your insurance is through a policy loan. When you take a life insurance loan, you don't owe taxes. As long as you don't end your policy, your loan will never be taxed. This gives you a way to spend your investment gains and never pay income tax. When you die, the loan will get paid out of your insurance death benefit. The downside of cashing out with a loan is that you need to keep paying for your life insurance. It also creates a small inheritance for your heirs.
David Rodeck has been writing professionally since 2011. He specializes in insurance, investment management and retirement planning for various websites. He graduated with a Bachelor of Science in economics from McGill University.